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Systemic RiskThe Dynamics of Modern Financial Systems$
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Prasanna Gai

Print publication date: 2013

Print ISBN-13: 9780199544493

Published to Oxford Scholarship Online: May 2013

DOI: 10.1093/acprof:oso/9780199544493.001.0001

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Dynamic Credit Relationships

Dynamic Credit Relationships

(p.48) (p.49) 4 Dynamic Credit Relationships
Systemic Risk

Prasanna Gai

Oxford University Press

This chapter draws on insights from the literature on coordination games and models of network growth to show how bank funding structure interacts with network topology. Funding markets can break down when coordination games are played across the entire financial network in response to the arrival of bad news. The results of the model highlight how dynamic balance sheet adjustment at the system level leads to hysteresis. Creditor optimism or pessimism about the decision to foreclose or refinance a loan is self-consistently maintained in the face of gradual changes to fundamentals.

Keywords:   interbank networks, rollover risk, hysteresis, global games, market freezes

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